What are Liquidity Pools?

Liquidity pools are pools of tokens that are locked in non-custodial smart contracts that are used to provide liquidity for trading on the exchange. When users put assets into a liquidity pool, they get Liquidity Pool (LP) tokens in return. These tokens represent a share of the assets in the pool that they own. LP tokens held are still visible in your private wallet, and can be liquidated at any point.

Liquidity pools on DIAMONDSWAP are completely trustless and non-custodial. Users retain ownership of their LP tokens at all times, and assets are not sent to the DIAMONDSWAP team. Instead, the pool is governed by smart contracts that execute trades automatically based on the pool's asset ratio.

Through the use of liquidity pools, users are able to seamlessly exchange assets on a decentralized exchange without the need for traditional market makers. By adding assets to the pools, liquidity providers play a key role in making this trading possible. At DIAMONDSWAP, we know how important liquidity pools are for a reliable trading experience, and we're dedicated to helping our users provide liquidity.

It's important to note that liquidity providers face the risk of impermanent loss when contributing to a pool. When the price of one token in a liquidity pool changes compared to another, the ratio of tokens in the pool changes, causing a temporary loss. Even though this risk is real, many users are still willing to provide liquidity because they receive a portion of the exchange's trading fees in return.

How Do Liquidity Pools Work?

Exchanges are based on order book models. In this order book model, buyers and sellers come together and place their orders. Buyers (Bidders) try to get in at the lowest price possible. Sellers try to sell at the highest price possible. For the sale to occur, the buyer and seller must converge and find a common ground that they agree upon. If no one can place their product at a fair price or there is not enough of a supply; that is where market makers come into play.

Market makers are entities that facilitate trading and allow for the ability to always buy or sell an asset. By doing that, they provide liquidity so that users can always trade and do not have to wait for another counterparty to show up.

In its basic form, an LP holds two tokens that creates a new market for those two pairs. When a new pool is created; the first liquidity provider is the one who sets the initial price of the assets in the pool, they are incentivized to supply an equal value of both tokens in the pool. If the initial price of the tokens in the pool diverges from the current global market price it creates an arbitrage opportunity, which can result in lost capital for the LP. LP Tokens are generated proportionally based on distribution.

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This video helps break down what liquidity pools are and why they are important. There is also a written explanation about this video as well.

Liquidity Pool Tokens

When you add your tokens into a Liquidity Pool pairing, you will receive 'Liquidity Provider' (LP) tokens and share in the trading fees that are gained through the transactional volume on our DEX.

As an example: If you deposit both $DMND and $ETH into a Liquidity Pool, you will receive DMND-ETH LP Tokens.

The number of LP tokens that you receive is a representation based on the portion of the DMND-ETH Liquidity Pool that you own.

You may also redeem your funds at any time by removing the liquidity that you initially provided.

Liquidity Provider Earnings

When providing liquidity, you receive a reward in the form of trading fees when people are using your liquidity pool.

When making a token swap (trade) on our exchange, traders will pay a 0.30% trading fee, of which 0.20% is added into the Liquidity Pool of the swap pairing that is being traded on.

An additional feature that we will have that allows you to earn more rewards for your LP tokens, on top of the pre-existing 0.2% trading fee, is our Yield Farms.